Future Opportunities: Latency...as challenged the status quo. Phone‐based manual traders have...

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Connecting to Future Opportunities: Cross‐Border Low Latency Connectivity

Cross‐Border Low Latency Connectivity March 2011


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TABLE OF CONTENTS EXECUTIVE SUMMARY.................................................................................................................................... 3

INTRODUCTION .............................................................................................................................................. 4

MARKET REALITY ............................................................................................................................................ 5

MARKET STRUCTURE CHANGES................................................................................................................ 5

INCREASE IN COMPETITION AND MARKET FRAGMENTATION ........................................................... 5

LEVEL OF ELECTRONIC TRADING ADOPTION....................................................................................... 9

GLOBALIZATION OF MARKET PARTICIPATION .................................................................................. 10

REGULATORY REALITY............................................................................................................................. 10

CHANGES IN DOMESTIC IT INFRSTRUCTURE .......................................................................................... 11

EXCHANGE TECHNOLOGY CHANGES................................................................................................. 11

IMPACT OF ELECTRONIC TRADING IN IT PLATFORMS OF MAJOR MARKET PARTICIPANTS.............. 13

GLOBAL EXPANSION OF HIGH FREQUENCY TRADING .................................................................................. 15

HIGH FREQUENCY TRADING IN MULTIPLE ASSET CLASSES..................................................................... 15

GLOBAL ADOPTION OF HIGH FREQUENCY TRADING.............................................................................. 16

IMPACT OF HIGH FREQUENCY TRADING ................................................................................................ 17

CHALLENGES AND OPPORTUNITES IN ASIA.................................................................................................. 19

THE NEXT FRONTIER IN HIGH FREQUENCY TRADING ............................................................................. 19

CHALLENGES IN ACCESSING ASIAN MARKETS ........................................................................................ 21

OUTSOURCING LOW LATENCY CONNECTIVITY TO ASIA............................................................................... 22

KEY COMPONENTS OF LOW LATENCY CONNECTIVITY IN ASIA............................................................... 22

BENEFITS OF OUTSOURCED LOW LATENCY CONNECTIVITY IN ASIA ...................................................... 23

LOOKING AHEAD..................................................................................................................................... 24



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EXECUTIVE SUMMARY

Connecting to Future Opportunities: Cross‐Border Low Latency Connectivity, commissioned by

NTT Communications and produced by Aite Group, analyzes new opportunities emerging from

Asian financial centers and examines the benefits and challenges of tapping into major Asian

financial centers, particularly with regard to connectivity and access. The study examines

growing trading opportunities in Tokyo, Singapore, and Hong Kong, and how having access to

cost‐effective, low latency connectivity across these major financial centers can create new

market opportunities for those firms looking to move beyond U.S. domestic markets.

Key takeaways from the study include the following:

Over the last few years, expected competition from off‐exchange liquidity pools and

adoption of sophisticated trading tools have generated much excitement within

major Asian financial centers.

As Asian exchanges begin overhauling their IT infrastructures to align themselves

with changing market microstructure, brokers and customers will need to focus on

updating their trading technologies to keep up.

Each major Asian financial center has its own unique set of infrastructure and

regulations, which makes it difficult for small market participants to actively

participate in Asia.

With high frequency trading firmly entrenched in the U.S. and European markets,

the Asian markets have become the next frontier of opportunities for most large

high frequency trading firms.

Operating in a trading environment in which every millisecond counts, firms with

aspirations in the Asian market must build their overall Asian strategy on top of cost‐

effective and reliable low latency connectivity infrastructure.

Given the integrated nature of today’s financial markets, an increasing number of market

participants in the United States are looking for cost‐effective ways to expand beyond their

borders and find opportunities in rapidly changing Asian markets.

In today’s marketplace, various outsourced vendor solutions offer not only reliable, low latency

connectivity to all major financial centers in both the U.S. and Asian markets, but also options for

colocation/proximity hosting and fully managed global support. With these essential

infrastructure components in place, the fear of distance latency between the two major financial

regions is no longer a major obstacle, allowing firms to focus on expanding their opportunities to

capture alpha across the two regions.



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INTRODUCTION

The dynamics within the global financial markets have changed dramatically over the last decade.

Adoption of electronic trading across all major regions has opened up new competition as well

as challenged the status quo. Phone‐based manual traders have become relics of the past, and

today’s market is increasingly dominated by electronic trading firms relying on low latency

infrastructure and microsecond trading strategies. The market makers of yesterday created a

lucrative business leveraging information advantage; today’s electronic market maker continues

to grow leveraging technology advantage.

Consolidation of the global exchange market has the potential to fundamentally change how and

where capital is raised. More importantly, however, the recent announcement of the potential

merger between NYSE Euronext and Deutsche Boerse is a clear indication that major financial

markets have become increasingly integrated and global in nature with exchanges seeking to

gain an advantage over competition under the new market environment by combining their

resources and coverage. It is no longer sufficient for a major market participant to focus on its

insulated domestic market. Instead, global opportunities must be sought out, and technology

will play a pivotal role in shrinking the global financial marketplace into a tightly intertwined

virtual marketplace.

While U.S. and European markets tend to garner most of the attention when it comes to market

structure changes and innovative IT adoption, one cannot simply overlook the vast opportunities

that currently exist in the Asian markets. Following the paths of their counterparts in the U.S.

and European markets, most major Asian financial centers are also going through fundamental

changes, albeit in a more deliberative way. In the exchange consolidation front, the Singapore

Exchange (SGX) launched a bid to acquire the Australian Securities Exchange (ASX) in late 2010.

This bid faces many obstacles, including potential political backlash in Australia, but it also

signals potentially the first salvo in a long‐awaited exchange consolidation trend in Asia. In Japan,

a recent news leak indicated a potential merger between the Tokyo Stock Exchange (TSE) and

Osaka Securities Exchange (OSE), with a possible consideration of Tokyo Commodity Exchange

(TOCOM) joining the mix, indicating willingness of domestic exchanges to work together to

combat competition from abroad.

Overall, changes are gradually occurring at the market structure level throughout major Asian

financial centers, and market participants are committing resources to develop high

performance trading infrastructure. Foreign and domestic high frequency trading firms have also

emerged in recent years in anticipation of significant opportunities.

Against this competitive backdrop, this study analyzes new opportunities emerging from Asian

financial centers and examines the benefits and challenges of tapping into Asian financial centers,

particularly with regard to connectivity and access. The study examines growing trading

opportunities in Tokyo, Singapore, and Hong Kong, and how having access to cost‐effective, low

latency connectivity across these major financial centers can create new market opportunities

for firms looking to move beyond domestic U.S. markets.



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MARKET REALITY

With competition in both U.S. and European markets maturing, the Asian financial markets

appear to represent the next frontier. Over the last few years, expected competition from off‐

exchange liquidity pools and adoption of sophisticated trading tools have generated much

excitement within major Asian financial centers. Until recently, however, regulatory, IT, business,

and cultural obstacles have hampered progress of impending market structure changes.

Still, changes are afoot; major market centers throughout Asia are making gradual moves toward

greater liberalization of regulations and upgrades in IT infrastructure, signaling their willingness

to participate in the global competition for liquidity and innovation.

This section briefly examines some of the key changes that have shaped the competitive

environment within the U.S. and Asian financial markets.

MARKET STRUCTURE CHANGES

INCREASE IN COMPET IT ION AND MARKET FRAGMENTAT ION

The U.S. equities market has undergone significant changes over the last decade, moving from a

virtual duopoly to a market structure characterized by extensive fragmentation and high levels of

electronic trading adoption. As a result, execution venues have had to fight for every single piece

of market share, leading to aggressive pricing and information distribution to attract additional

liquidity. This competition has led to creation of a more efficient and transparent marketplace.

Competitive market environment and regulatory changes have also resulted in substantial

tightening of spreads. At the same time, sourcing and interacting with liquidity has become more

complex for buy‐side clients, driven by proliferation of multiple execution venues and declining

depth at public markets’ national best bid and offer (NBBO).

Nothing epitomizes the drastic change in U.S. market structure more than the rapid market share

decline of NYSE Euronext; its market share declined from close to 50% in 2004 to 28% at the end

of 2010 (Figure 1). While the combined market share of traditional exchanges, represented by

NYSE Euronext and NASDAQ OMX, has declined substantially since 2009, exchanges have

collectively recaptured market share. Most of the recent market share wins have come via

leading electronic communication networks (ECNs) such as BATS and Direct Edge acquiring

exchange licenses. Exchanges accounted for close to 75% of market share at the end of 2010,

followed by dark pools, with 12%. Other displayed alternative trading systems (ATSs) and

wholesale market makers represent about 13% of total market share (Figure 2).



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Figure 1: Shrinking NYSE Euronext Market Share

Source: NYSE Euronext, NASDAQ OMX, BATS Exchange, Direct Edge, Broker/Dealers, Aite Group

Figure 2: Market Fragmentation in the U.S. Equities Market

Source: NYSE Euronext, NASDAQ OMX, BATS Exchange, Direct Edge, Broker/Dealers, Aite Group

In Japan, Singapore, and Hong Kong, incumbent exchanges, TSE, SGX, and Hong Kong Exchange

and Clearing Limited (HKEx), continue to dominate their domestic markets, each exchange

accounting for more than 90% of its domestic market share in trading volume (Figure 3).



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Figure 3: Current Reality in Major Asian Exchanges

Source: Tokyo Stock Exchange, Singapore Exchange, Hong Kong Exchange and Clearing Limited, Aite Group

The adoption rate of first‐generation Asian ATSs, hampered by lack of pan‐Asian regulations and

robust trading infrastructure and coupled with low customer interest, has failed to live up to

market expectations. Still, competition has been building over the last few years from

independent alternative execution venues and global broker/dealers that are fine‐tuning the

crossing services they have designed for the Asian market.

Table A: Sample List of ATSs in Asia

Firm Launch Date Country of Operations

Ownership Type

AXE ECN N/A Expected in Australia, New Zealand

NZX, Citigroup, CommSec, Goldman Sachs JBWere, Macquarie Bank, and Merrill Lynch

Displayed

BlocSec 2008 Hong Kong, Singapore, Japan

CLSA Asia‐Pacific Markets

Non‐Displayed

Chi‐East 2010 Singapore SGX and Chi‐X Non‐Displayed

Chi‐X 2011 Expected in Australia, Japan

Nomura Holdings Inc.

Displayed

Crosspoint 2010 Hong Kong, Japan Tora Trading Non‐Displayed

Kabu.comPTS 2006 Japan

Kabu.com, Credit Suisse, Mitsubishi UFJ Securities, UBS, BNP Paribas

Displayed



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Firm Launch Date Country of Operations

Ownership Type

Liquidnet Asia 2007 Hong Kong, Singapore, Japan, Australia

Liquidnet Holdings Non‐Displayed

Monex Nighter 2001 Japan Monex Displayed

SBI Japannext 2007 Japan

SBI Holdings, Goldman Sachs, Rakuten, ORIX, CLICK, Credit Suisse, Merrill Lynch, etc.

Displayed

Source: PTS

Japan: While some of the earliest ventures into the alternative liquidity markets can

be traced back to Japan, first‐generation ATSs (referred to as PTSs in Japan to denote

their legal name, proprietary trading systems) typically originated from retail online

brokerage firms looking to add trade volume during after‐market hours. In recent

years, however, SBI Japannext and Kabu.comPTS have attracted investments from

global brokers and launched competitive services during TSE market hours.

Singapore: BlocSec is a crossing network for institutional investors looking to

execute block trades of securities listed on the SGX. Having met with mixed results,

BlocSec has retreated into CLSA, its parent company. The launch of Chi‐East, a non‐

displayed pool joint venture between SGX and Chi‐x, is being watched quite closely;

it is the only example in Asia of an incumbent exchange working closely with a

potential rival to create an alternative dark pool.

Hong Kong: The Securities and Futures Commission (SFC) in Hong Kong has allowed

off‐exchange trading through issuance of type‐7 license (registration to operate

Automated Trading Services, or ATSs), but it has been quite selective in terms of

approval, and all ATSs must report and clear through HKEx.

In addition to these alternative pools, brokers have launched their non‐displayed crossing

engines across key financial centers in Asia. Sample brokers and their crossing capabilities across

a few major Asian financial centers are highlighted in Table B.

Table B: Broker Crossing Initiatives in Asia

Broker Crossing Platform

Australia Hong Kong Japan Korea Singapore

Citi Citi Match No Yes Yes No No

Credit Suisse Crossfinder Yes Yes Yes No Yes



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Broker Crossing Platform

Australia Hong Kong Japan Korea Singapore

Deutsche Bank

Deutsche Bank ATS

No Yes Yes No No

Goldman Sachs

SIGMA X No Yes Yes No No

Instinet CBX in HK and Japan JapanCross in Japan KoreaCross in Korea

No Yes Yes Yes No

ITG POSIT Yes Yes Yes No No

Merrill Lynch

MLXN No Yew Yes No No

Morgan Stanley

MS Pool No Yes Yes No No

UBS PIN Yes Yes Yes No No

Source: Broker/Dealers

While independent ATSs faced with inflexible regulations struggle to begin operations, most

broker/dealers have operated their own internal crossing platforms for a couple of years now,

mainly focused on the Japanese and Hong Kong markets. As markets become more electronic

and major Asian market centers begin to fragment, these internal crossing engines will enable

broker/dealers to provide a wide array of liquidity services to their clients.

LEVEL OF ELECTRON IC TRAD ING ADOPT ION

The rapid adoption of electronic trading is no longer an American phenomenon. All major

exchanges globally currently operate electronic matching engines. While broker/dealers have led

the way in development of sophisticated trading applications, various client segments globally

have fully embraced the concept of electronic trading, including actively trading hedge funds and

high frequency proprietary trading firms.

Estimated adoption of electronic trading is predictably quite high across the major exchange‐

traded instruments, including equities, futures, and options. While it is an over‐the‐counter

(OTC) product, the extremely liquid FX market also represents a truly global, electronic

marketplace (Figure 4).



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Figure 4: Estimated Adoption of Electronic Trading

Source: Aite Group

GLOBAL I ZAT ION OF MARKET PART IC IPAT ION

Beyond the obvious interests between the U.S. and European markets, financial markets in Asia

are increasingly becoming important locations for global broker/dealers and their customers

alike. As firms seek new opportunities across the globe, however, a few obstacles have become

apparent:

Potential for political and regulatory instability;

Lack of consistency in IT infrastructure within emerging markets;

Existence of protectionist policies to insulated domestic incumbent exchanges and

financial service firms from external competition;

Exorbitant costs of developing local presence; and

Lack of viable third‐party vendor community.

Despite these hurdles, globalization of financial markets will continue as firms look to diversify

their risk and optimize their existing organizational and IT infrastructures.

REGULATORY REALITY

Regulatory pressures continue to rise, especially after the credit crisis of 2008. No market

appears to be safe from regulatory scrutiny. In the United States, the entire market

microstructure has come under the microscope in the exchange‐trade markets, including

equities, options, and futures. In the cash equities market, many regulatory discussions have



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taken place over increasing market fragmentation, growing market share of dark pools,

controversy around naked market access, and market clout of high frequency trading. In the OTC

market, the focus has been on centralized clearing and increased transparency in the most liquid

OTC products, including vanilla interest rate swaps (IRS) and credit default swaps (CDSs). There is

also the proposal for the creation of Swap Execution Facilities (SEF) in the U.S. OTC market,

where transactions of standardized swap instruments are expected to take place.

In Asia, Japan appears to be the most similar to the United States in terms of having a regulatory

precedence for the existence of alternative execution venues. In fact, Japan has had PTSs

operating for close to a decade. Within this regulatory framework, the TSE set in motion

potential competition against various PTSs with the launch of arrowhead in January of 2010.

After years of regulatory frustration, Australia appears to be heading in the right direction with

the approved handover of market supervision from ASX to the Australian Securities Investments

and Commissions (ASIC). This change would pave the way for the eventual entrance of new

competition in the Australian market, which is not expected until at least the second half of 2011.

Following a mixed reception of Asia’s first local crossing platform, BlocSec, SGX is working with

Chi‐X to launch Chi‐East, an exchange‐integrated dark pool. Perhaps more importantly, SGX has

launched a bid to acquire ASX in an attempt to create a powerful new Asian exchange,

potentially paving the way for exchange consolidation in Asia.

CHANGES IN DOMESTIC IT INFRSTRUCTURE

EXCHANGE TECHNOLOGY CHANGES

The massive changes in IT infrastructure within the U.S. financial markets have made it possible

for the emergence of hypercompetitive environment over the last decade. All U.S. exchanges

currently operate in hundreds of microseconds, and offer colocation and proximity access

solutions to ensure they are able to accommodate the latency‐sensitive customer base.

With the launch of arrowhead in January 2010, the TSE ushered a new wave of competition into

the Japanese equities market. It also created excitement in other major Asian financial centers,

providing a glimpse of what the future may hold in terms of Asian‐wide market structure

changes. By lowering latency, offering colocation options, and changing specific rules to increase

trade volume and tighten spreads, arrowhead is expected to have a substantial impact on the

overall development of the Japanese market, including increased high frequency trading flow,

growing market competition, and declining execution costs.

TSE’s recent agreement with NYSE Euronext to explore possible interconnection of their

respective networks, arrownet™ and Secure Financial Transaction Infrastructure (SFTI®),

indicates current market dynamism that requires cross‐border low‐latency solutions for investors

in both markets.



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Figure 5: Launch of arrowhead in Tokyo Stock Exchange

Source: Tokyo Stock Exchange

Not surprisingly, other Asian exchanges have followed suit in terms of committing substantial

resources to launch new or upgrade existing exchange technology infrastructures. Table C

presents brief descriptions of new IT initiatives within major Asian exchanges.

Table C: New Exchange Technology Initiatives

Exchange Initiative Launch Date Details Latency and Capacity

TSE Launch of arrowhead

Jan 4, 2011

Next‐generation low latency exchange trading platform with colocation service

Matching engine processing speed of 5 milliseconds, 4.68 million orders per day

ASX Launch of ASX Trade

Dec 3, 2010

Next‐generation low latency exchange trading platform for both derivatives and cash markets using NASDAQ OMX’s Genium INET platform

Matching engine processing speed of 300 microseconds, 100,00 orders per second

HKEx Planned upgrades to AMS

In progress Plans to improve latency and capacity of its existing platform

Matching engine processing speed of 9 milliseconds, 30,000 orders per second

SGX Planned launch of SGX Reach

Expected launch in Aug 2011

Next‐generation low latency exchange trading platform for cash markets using NASDAQ OMX’s Genium INET platform

Matching engine processing speed of 90 microseconds, 1 million orders per second

OSE Launch of J‐GATE

Feb 2011 Next generation trading platform using NASDAQ OMX’s CLICK XT platform

Matching engine processing speed of 5 milliseconds, 12,000 orders per second

Source: Exchanges



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ASX initiatives: Leveraging NASDAQ OMX’s Genium INET platform, ASX’s next‐

generation trading platform, ASX Trade, provides drastic improvement in overall

performance, handling 100,000 orders per second compared with 20,000 orders per

second in 2008; ASX Trade also significantly reduces latency, averaging 300

microseconds today compared with 30 milliseconds in 2008. The new trading system

has been launched in conjunction with expanded colocation facilities, rollout of ASX

Net (low latency, fully managed network), and enlarged data center.

HKEx initiatives: Aiming for end of 2011 as the deadline, HKEx is currently

undergoing upgrades to its existing trading and market data distribution systems,

Automatic Order Matching and Execution System (AMS) and Market Data System

(MDS), respectively. As a result, the enhanced AMS will increased its overall capacity

tenfold, averaging 30,000 orders per second and reducing average latency to nine

milliseconds, which would be 16 times faster than the current average. AMS will also

be able to display 10 levels of price rather than the current five. On the market data

side, MDS will be able to double its data dissemination throughput to 2,000 stock

page updates per second. In addition to system upgrades, HKEx will be offering low

latency colocation services at its next‐generation data center (NGDC) in Hong Kong’s

Tseung Kwan O Industrial Estate. The migration into the next NGDC is scheduled to

be completed by Q4 2012.

SGX initiatives: Committing US$250 million to the project, SGX has begun an

ambitious IT infrastructure overhaul of its existing platform. Leveraging NASDAQ

OMX’s Genium INET platform, SGX will dramatically lower its average latency level to

90 microseconds with the ability to handle 1 million orders per second. In addition

to the new platform, SGX will be offering low latency, fully managed colocation

services via its new data center at Keppel Digihub. In an attempt to attract greater

cross‐border flow, SGX will also establish presence in major data centers in Chicago,

New York, London, and Tokyo.

OSE initiatives: While TSE dominates the Japanese cash market, there are numerous

derivatives exchanges in Japan, including OSE, Tokyo Financial Exchange (TFX), and

TOCOM. OSE represents the largest derivatives market in Japan by a wide margin,

with TFX and TOCOM ranked as the second and third largest respectively. OSE

launched its new trading platform J‐GATE, leveraging NASDAQ OMX’s CLICK XT

platform, dramatically lowering its order processing latency from 100 milliseconds to

5 milliseconds. The matching engine’s throughput has also improved with the ability

to process 12,000 orders per second. In addition, OSE has expanded its colocation

environment and transitioned into a new integrated network, GATENET, to

accommodate J‐GATE’s enhanced performance.

IMPACT OF ELECTRON IC TRAD ING IN I T P LATFORMS OF MAJOR MARKET

PART IC IPANTS

As exchanges begin overhauling their IT infrastructures to align themselves with changing market

microstructure, brokers and customers will need to focus on updating their trading technologies

to keep up. Some of the areas for potential change include the following:



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Intense pressure on broker/dealers to upgrade IT infrastructure to compete in a low

latency, potentially fragmented trading environment, including focus on direct

market access (DMA), algorithms, smart order routing, pre‐trade risk compliance,

colocation, connectivity, and more;

Increased use of self‐directed trading technologies by customers in addition to

continued support from brokers to better understand the changing trading

environment;

Growing importance of trading analytics to properly measure overall trading

performance in pre‐trade, intraday, and post‐trade basis; and

Need to discover cost‐effective solutions to support increasingly global nature of

their business, including trading applications, hosting, connectivity, and more.



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GLOBAL EXPANSION OF HIGH FREQUENCY TRADING

Undoubtedly, one of the major changes over the last few years has been the expansion of high

frequency trading across major asset classes and regions. Attracted by markets that exhibit high

levels of liquidity, market transparency, consistent regulatory regime, and inherent inefficiencies,

high frequency trading firms have moved well beyond the U.S. equities market to become a

major driving force for change and innovation worldwide.

HIGH FREQUENCY TRADING IN MULTIPLE ASSET CLASSES

While the cash equities market still garners most of the publicity involving high frequency

trading, major low latency players have moved into multiple asset classes:

Figure 6: Estimated Adoption of High Frequency Trading

Source: Aite Group

Listed options and futures: Exhibiting high levels of liquidity and low latency market

IT infrastructure, U.S. exchange‐traded equity options and global futures markets

have become popular markets for high frequency trading.

FX: As one of the few OTC products to be very liquid, FX has been an active market

for high frequency trading firms for the last few years. The market remains highly

electronic, with competition for flow across multiple single bank, multi‐bank, and

interbank platforms. High frequency trading firms have become major players in FX,

often accounting for more than 40% of average daily volume in major FX execution

venues.



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Fixed income: While the fixed income market lags in terms of liquidity and

transparency, active high frequency trading market does exist in the U.S. treasuries

market, especially within interbank trading platforms such as eSpeed and BrokerTec.

GLOBAL ADOPTION OF HIGH FREQUENCY TRADING

Starting with the U.S. market, high frequency trading has spread across the globe in a relatively

short period of time (Figure 7). While Europe has been slated for the next huge adoption of high

frequency trading, the Canadian equities market has in recent years experienced a significant

presence of high frequency trading flow, typically accounting for close to 40% of average daily

trade volume.

Figure 7: Estimated Adoption of High Frequency Trading in Major Regions

Source: Aite Group

U.S. market: The U.S. market currently leads the world in high frequency trading

adoption with approximately 65% of daily trade volume.

Europe: With increasing market fragmentation and adoption of sophisticated trading

tools, a growing number of high frequency trading firms have participated in the

European equities market. High frequency trading in Europe currently represents

about 30% of daily trade volume.

Asia‐Pacific: Unlike the other two major financial regions, the Asian market remains

fairly insulated when it comes to high frequency trading, with certain financial

centers being more open to accommodate the growth of high frequency trading.

With the launch of arrowhead and related products and services that are attractive

to high frequency trading community, TSE has been actively recruiting high

frequency trading flow. As a result, more than 25% of daily volume can be attributed

to high frequency trading volume. Within the SGX, the derivatives market has been a



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popular market for high frequency trading, representing 30% of daily volume.

However, the cash equities side remains under‐adopted, with approximately 7%. In

Hong Kong, high frequency trading in the cash market is eve lower than Singapore

with 5% (Figure 8).

Figure 8: Estimated High Frequency Trading in Major Asian Exchanges

Source: Tokyo Stock Exchange, Singapore Exchange, Hong Kong Exchange and Clearing Limited, Aite Group

IMPACT OF HIGH FREQUENCY TRADING

The various changes in market structure have made it possible for active participation of high

frequency trading firms. As high frequency trading continues to grow across regions and asset

classes, major financial centers globally have experienced fundamental changes across trading, IT,

and regulatory environment.

Increase in trade volume: The most obvious impact has been substantial increase in

trading volume. At the same time, overall messaging volume has spiked, driven by

the active nature of high frequency trading and high levels of cancellation rates.

Tighter spreads and decrease in explicit execution cost: As high frequency trading

firms have become modern‐day market makers, competition for flow has intensified,

leading to much tighter spreads. While debates continue over potentially rising

implicit execution costs related to market impact, there is no doubt that explicit

execution costs have dropped dramatically for both institutional and retail investors.

Growing demand for high performance, low latency infrastructure upgrades: In

order to properly participate in a fast trading environment, IT infrastructures of all

major market participants, including exchanges, broker/dealers, hedge funds, asset

managers, and proprietary trading firms, have been under a tremendous amount of

pressure for upgrades. Operating in a microsecond trading environment dictates that



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every precious second could mean the difference between millions of dollars of

opportunities won or lost.

Increased regulatory scrutiny: Unfortunately, as market clout of high frequency

trading firms continues to increase, regulators have become that much more

concerned about the ultimate impact of high frequency trading on the well‐being of

the entire market structure.



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CHALLENGES AND OPPORTUNITES IN ASIA

Unlike in the U.S. and European markets, Asia lacks a single, pan‐Asian capital market. In

addition, compared to the leading exchanges in the U.S. market, all major Asian exchanges have

a long way to go in terms of reducing transactions costs, which should lead to enhanced liquidity

and volume. While both NYSE Euronext and NASDAQ OMX currently average fewer than seven

basis points in terms of spreads, major exchanges in Asia are closer to 20 basis points, with

Singapore exhibiting a significantly higher average spread of 37 basis points (Figure 9).

Figure 9: Comparative Analysis of Spreads

Source: Exchanges, Aite Group

Even though the prospect of cheaper executions is certainly appetizing, local buy‐side customers

are also hesitant about the potential trade‐off of increased complexity in market structure and

additional spending on their own IT infrastructure. While most domestic and foreign brokers

have adopted advanced trading technologies, the local buy‐side community still relies heavily on

telephones and brokers to meet their trading objectives. Lack of understanding regarding

sophisticated trading tools, coupled with a dearth of IT knowledge on the buy‐side, adds

complexity to driving adoption of advanced trade execution tools, including DMA, algorithms,

and ATSs.

Despite the challenges, increased market competition looks inevitable, and the ability to scale

for both market centers and brokers will be crucial to providing world‐class service to a core

customer base. Market structure changes are occurring across major Asian financial centers

despite regulatory, infrastructural, and cultural obstacles.

THE NEXT FRONTIER IN HIGH FREQUENCY TRADING



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With high frequency trading firmly entrenched in the U.S. and European markets, the Asian

markets have become the next area of opportunities for most large high frequency trading firms.

Certain regulatory and structural issues still exist across major Asian countries, including vertical

integration of clearing facilities with existing exchanges, questionable depth of market and

liquidity, wide spreads, and large minimum tick size, all of which still pose major obstacles for

active participation of high frequency trading firms. Significant changes are occurring in major

Asian financial centers, however, that have caught the attention of serious global trading firms:

Investments in exchange technology: Major Asian exchanges, including TSE, ASX,

SGX, and HKEx, have committed hundreds of millions of dollars to upgrade their

existing technology platforms and offer colocation and proximity solutions to attract

actively trading global market participants.

Active presence of global broker/dealers: Sensing greenfield opportunities, global

broker/dealers have already created significant local presence in multiple Asian

markets, armed with sophisticated trading solutions, including DMA, algorithms,

smart order routing, and cross platforms.

Continued development of alternative execution venues: Despite the slow start,

alternative execution venues continue to chip away at market share of incumbent

exchanges. While the most progress has been made in Tokyo, the battle for market

share is expected to intensify in coming years across the region, leading to increased

market transparency, declining transaction costs, and ultimately changes in

regulations to accommodate market competition.

The biggest hurdle for market and IT innovation has been the lack of a pan‐Asian market; each

country has its own set of issues and concerns, and local customs and beliefs dictate market

practices. This deficiency has also meant the absence of a centralized pan‐Asian regulatory body

and harmonized market standards, prolonging the overall adoption cycle and forcing both buy‐

side firms and service providers to take a country‐by‐country approach. In general, most Asian

markets discourage off‐exchange transactions.

Depending on the country, clearing and settlement is another area of concern. In Hong Kong,

Australia, and Singapore, the primary exchanges own the clearing and settlement organizations.

ATSs view clearing and settlement that fall under the umbrella of the incumbent exchanges as a

conflict of interest, representing another hurdle for ATSs to overcome and further delaying

competition in the Asia‐Pacific region.

Potential changes in Japan will be essential for further changes across other Asian markets. The

opening of horizontally integrated Japan Securities Clearing Corporation (JSCC) to clear executed

trades from PTSs will be another important piece of the puzzle in increasing market competition

in Japan. Once Japan has been confronted with increased fragmentation and competition, other

markets—Australia, Hong Kong, and Singapore in particular—should be the next financial

centers primed for change. Before massive changes can occur, however, each financial center

must meet certain conditions:

Regulatory acceptance of off‐exchange, ATS trading;



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IT infrastructure in place to support electronic trading and expected increase in

overall messaging volume;

Horizontal integration of clearing and settlement infrastructure to support multi‐

venue competition; and

Exchange rule changes designed to foster trade volume, including decreasing

minimum tick size and lowering trading costs.

CHALLENGES IN ACCESSING ASIAN MARKETS

For large global market participants, accessing key Asian markets could mean simple resource

allocation and a redirection of certain budget items to actively participate in the Asian markets.

For most other firms, there are many challenges to participating in the next Asian electronic

revolution:

Too expensive to create local presence: Not many firms globally have enough scale

and budget to build local presence across all major Asian financial centers.

Concern for built‐in distance latency: For those firms based in the United States and

looking to participate in either Tokyo or Singapore, serious concerns arise regarding

competitive disadvantage due to distance latency given the emergence of low

latency trading flow in those markets.

Potential for multiple vendor relationships: Development of a highly effective

trading infrastructure in Asia would require, at minimum, colocation/proximity

option, low latency connectivity, market‐specific strategy development, smart order

routing, and market data platform. For those firms with a focused Asian strategy,

securing reliable, low latency access into the various Asian financial centers might

lead to the creation of multiple layers of vendor relationships and thus to much

higher costs and compatibility issues, which could negatively impact time to market.



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OUTSOURCING LOW LATENCY CONNECTIVITY TO ASIA

An obvious lesson from the 2008 credit crisis has been that major financial markets are truly

intertwined; the ability, then, to take advantage of opportunities globally remains the only viable

strategy in today’s hypercompetitive marketplace. With Asian markets continuing to grow rapidly,

U.S. market participants have been actively looking for ways to incorporate key Asian markets

into their portfolio. Attempting to build out a low latency connectivity infrastructure internally

would be cost prohibitive for most firms. Fortunately, many vendor options currently exist,

which firms could leverage to outsource the entire operation.

Operating in a trading environment in which every microsecond counts, firms with aspirations in

the Asian market must build their overall Asian strategy on top of cost‐effective and reliable low

latency connectivity infrastructure.

KEY COMPONENTS OF LOW LATENCY CONNECTIVITY IN ASIA

In order to develop a fully integrated global trading operations focused on Asia, the following

components must be addressed, whether internally developed or vendor‐provided:

Figure 10: Cross‐Border Linkage Connecting U.S. and Asian Financial Centers

Source: Aite Group



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Low latency connectivity to all major Asian financial centers. With opportunities

emerging across multiple Asian financial centers, building low latency connectivity to

all major locations is the most basic requirement for any firm with Asian aspirations.

Colocation and proximity options. In addition to connectivity, the ability to colocate

or leverage a proximity facility provides a clear competitive advantage to those firms

trying to overcome issues associate with distance latency.

Reliability and consistency in connection. For those firms without local physical

presence, the reliability and consistency in connectivity to major exchanges and

execution venues in Asian financial centers enables them to employ their various

trading strategies with utmost confidence.

Availability of managed operations. Most firms do not have a large in‐house IT staff

that can be leverage across the globe to maintain their trading infrastructure.

Vendors capable of providing a fully managed, hosting services with low latency

connectivity to multiple Asian financial centers enable firms to focus on finding

profitable trading opportunities while keeping their global infrastructure overhead

affordable.

Global customer support. In a global trading environment, global customer support

is essential and should include ability to provide ongoing support regardless of the

client’s time zone.

BENEFITS OF OUTSOURCED LOW LATENCY CONNECTIVITY IN ASIA

Once a robust and fully scalable low latency connectivity infrastructure is in place, firms can

begin developing trading strategies linking various Asian and U.S. markets together, and looking

for those hard‐to‐find trading opportunities that may exist for only a split second. Other

important benefits of an outsourced low latency connectivity arrangement in Asia include the

following:

Cost‐effective way of creating a trans‐Pacific presence: Leveraging the

infrastructure of a vendor whose sole purpose is maintain and constantly improve

the performance of the connectivity solution, a fully managed outsourced solution

enables firms to focus on developing trading strategies that can cost‐effectively

capture opportunities in Asian and U.S. markets.

Harmonizing trading infrastructure to participate in multiple markets. Leveraging a

single vendor relationship, firms can gain instantaneous low latency access to

multiple markets in both Asia and the United States, making it easier for firms to

simplify their trading infrastructure and streamline their vendor relationships.

Diversification of risk: The ultimate goal of global trading is to capture new revenue

opportunities while simultaneously diversifying the risk inherent in focusing in a

single market.



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LOOKING AHEAD

Over the last decade, key market structure changes and innovations in technology and financial

products have created a truly global financial marketplace. Given the integrated nature of

today’s financial markets, an increasing number of market participants in the United States are

looking for cost‐effective ways to expand beyond their borders and tackle opportunities in

rapidly changing Asian markets.

With ongoing market structure changes and an influx of high frequency trading firms in Asia,

those firms interested in capturing higher returns in Asia must look to leveraging low latency

connectivity platforms to ensure that those opportunities are not missed. Getting access to such

an infrastructure once meant multiple vendor relationships across many Asian financial centers,

and dedication of in‐house IT staff resources to ensure reliability. This approach was more often

than not only possible for the largest global firms.

In today’s marketplace, various outsourced vendor solutions exist that offer not only reliable,

low latency connectivity to all major financial centers in the U.S. and Asian markets, but also

options for colocation/proximity hosting and fully managed global support. With these essential

infrastructure components in place, the fear of distance latency between the two major financial

regions is no longer a major issue, and firms can focus on expanding their opportunities to

capture alpha across the two regions.

Future Opportunities: Latency...as challenged the status quo. Phone‐based manual traders have...

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